Non-competes Push Talent Away

California is among several states where non-compete agreements are essentially illegal. Is it a coincidence that so many inventors flock to Silicon Valley? New research by Lee Fleming, Matt Marx, and Jasjit Singh investigates whether there is a "brain drain" of talented engineers and scientists who leave states that allow non-competes and move to states that don't. Key concepts include:

The research shows that inventors are leaving states that allow non-competes and moving to states that don't.

The results are most pronounced among those inventors with the most patent citations—that is, those who are most productive, collaborative, and valuable to their firms.

The researchers hope that their study will induce state legislators to consider regional rules regarding non-compete agreements.

by Carmen Nobel

Several years ago, on his first day of work at a Boston-based speech-recognition software company, Matt Marx's new employer surprised him with a non-compete agreement. The terms stated that if Marx left the company, he couldn't work anywhere else in the industry for two years. While he was disturbed that nobody had mentioned the non-compete before he accepted the job, Marx signed willingly, assuming such documents were commonplace.

"It's clear that that inventors are leaving states that enforce non-competes for states that don't."

Fast-forward a few years later. Marx was a manager at a start-up firm in Silicon Valley when one of his employees decided to quit and go work for a direct competitor down the street. "I told him, 'Hey, you can't do that. Didn't we make you sign a non-compete?' " Marx recalls. "He kind of laughed at me and said that non-competes weren't enforceable in California.

Sure enough, California is among several states where non-compete agreements are substantially restricted by law, along with Alaska, Connecticut, Minnesota, Montana, Nevada, North Dakota, Oklahoma, Washington, and West Virginia. So, even if someone signs a non-compete agreement in Massachusetts, for instance, a judge in California is not obligated to enforce the contract because it conflicts with California state law.

"There's a saying out in California: You never stop hiring someone," says Marx (MBA '05, DBA '09), now an entrepreneurship professor at MIT Sloan who wrote his dissertation on non-competes while in the doctoral program at Harvard Business School. "There's an open labor market," he continues. "People can leave when they want. They're not trapped at companies the way they are in Massachusetts. And that's what changed the way I worked as a manager. I realized that I couldn't treat employees like resources. I had to work to keep them excited to stay around."

Marx is the coauthor of a yet-to-be-published paper that investigates whether states that allow non-compete agreements are driving high-tech talent away—creating a so-called brain drain of smart inventors. In "Regional Disadvantage? Non-Compete Agreements and Brain Drain," the researchers show that non-competes indeed factor into an inventor's decision to emigrate, within the United States, to states that disallow non-competes.

"It's clear that inventors are leaving states that enforce non-competes for states that don't," says Lee Fleming, a professor at Harvard Business School who coauthored the paper with Marx, along with INSEAD professor Jasjit Singh (PhDBE '04).

To test their brain drain theory, the researchers analyzed the US patent record from 1975 to 2005, in order to track the emigration patterns of hundreds of thousands of inventors over two decades. (They considered only inventors who held multiple patents.)

"Patenting inventors represent an important category of skilled workers involving the sorts of trade secrets firms seek to protect using non-competes," their paper explains. "Each patent typically contains each inventor's hometown and employer, making it possible to reconstruct work histories and co-authorship networks for numerous individuals."

Draining Detroit

Initially, the researchers looked for emigration patterns in the United States. In attempting to define the non-compete status in Michigan, they discovered a natural test bed, thanks to an inadvertent policy change. In 1905, during the initial automotive industry boom, Michigan passed Public Act No. 329, which prohibited "all agreements and contracts by which any person…agrees not to engage in any avocation or employment"—including non-compete agreements. But in 1985, the state passed the Michigan Antitrust Reform Act (MARA), which sweepingly repealed dozens of laws and acts, including the inadvertent repeal of Public Act No. 329. Suddenly, non-compete agreements were legal in Michigan.

"This is an ideal natural experiment where you take a population of people—namely, the inventors in Michigan before the law changed—and then you subject them to this shift in enforcement," Fleming explains.

"Policy makers in these states are really shooting themselves in the foot."

The results showed that the legalization of non-competes had a definite brain drain effect. Indeed, after the passage of MARA, more inventors left Michigan for states that did not enforce non-competes than for states that did.

The paper explains that from 1975 to 1996—the period surrounding the 1985 policy reversal—the rate of emigration grew in Michigan (0.24% to 1.18%) while dropping in states that did not enforce non-competes (0.20% to 0.13%). The relative risk of post-MARA emigration was 1.353 in Michigan, 99.9% higher than in states that continued not to enforce non-competes (where the relative risk of post-MARA emigration was 0.677). Furthermore, the Michigan emigrants primarily were moving to states that did not enforce non-competes.

While the results supported the brain drain hypothesis, the researchers worried that they might be skewed by patent holders who had moved to California, a state that might be especially attractive to inventors irrespective of its non-compete policies, which have been in effect since 1872. In both landmass and population, California is disproportionately large compared with most other states, which could account for more job opportunities. Silicon Valley, especially, is known as an inventor's mecca. And let's not forget the incessant sunshine.

"The problem was causality," Fleming says. "Are people going to California because they're trying to get out of the non-compete in their original state, or are they going to California for the weather or whatever else?"

That in mind, the research team investigated whether the results would change if they excluded all the data related to inventors who moved to California. Indeed, even without the pull of Silicon Valley, the brain drain theory still held true: Michigan inventors also tended to emigrate to other states that disallowed non-competes.

The best and brightest

The researchers found that the brain drain was especially pronounced among inventors who held multiple and high-impact patents, and among inventors who also collaborated widely—in other words, those who were considered most valuable to innovation in their firms

The relative risk of post-MARA emigration by more productive inventors, holding more than the median number of overall patent citations, was 187 percent higher in Michigan than in states that continued not to honor non-competes. But the relative risk of post-MARA emigration by Michigan inventors at or below the median number of patents was only 46 percent higher.

"I think the real punch line here is that it appears that it's the better inventors who are more likely to respond to these laws," Fleming says. "It's the people who have lots of patents, it's the people who have high-impact patents, it's the ones with many coauthors. Prior research has shown that the best engineer is worth much more than the average engineer. And if those are the people whom the states are losing, it's a big hit. Policy makers in these states are really shooting themselves in the foot. Some have argued that firms will not invest in R&D unless they can keep their people, but other research by Mark Garmaise at UCLA has shown just the opposite."

To that end, Marx and Fleming have shared their findings with government officials in their home state of Massachusetts, where legislators are considering a bill that would restrict the terms of non-compete agreements in the state. A hearing is set for September 15. Brain drain is arguably an issue in Massachusetts, which reportedly retains only about 60 percent of its college graduates.

Meanwhile, they hope hiring managers will take the issue to heart.

"If you're starting a company, you might want to think about non-competes when you talk about where to locate your business," Marx says. "And if you're considering non-competes, think about whether you want to develop a reputation as a company that tries to put a hammerlock on your employees."

About the author

Carmen Nobel is senior editor of HBS Working Knowledge.

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Comments

Leslie Gangwish

MBA '08, Ohio State University

As it is that each state has its own evolving laws on the subject of non-competes, did the researchers reject the moves of inventors to states (or companies) which at the time of the move had more or equally stringent law (per the researcher's standards) than the one that s/he just left? Will the researchers also pair surveys of inventors which actually ask them why they moved and/or what influence non-compete law had on their move? Perhaps it wasn't the lack of non-competes but rather the more attractive consideration which made them change employers. What do the professors in the Harvard Law School have to say about the premise of this research?

Anonymous

There is one fatal flaw in using Michigan for your test bed. It is also driven by the auto industry in the US and the mid-eighties saw the decline of that industry and the movement of new manufacturers into other states... Do you actually believe that Honda, Toyota or BMW considered non-compete agreements in deciding where to locate their facilities? Unlikely as most of their R&D is done outside the US altogether... yet how many of those movements by foreign automakers into the US impacted manufacturers in Michigan.

Sorry, but using Michigan as a lab wasn't a good idea.

Anonymous

I would suggest to the authors that the Michigan brain drain had much more to do with the long-term demise of the automotive industry than it had anything to do with non-compete agreements. Just as California might attract inventors for other reasons, there was one huge other reason why Michigan would lose inventors.

john edelson

founder & CEO, http://www.spellingcity.com

I'd question the value of this research as a little too ivory-towerish. There is evidence is that MI tech people emigrated to other states. It seems they went to states with better high tech climates. One of the aspects of this is the non-compete.

At the end, so what? Maybe they went to places with better labor pools, more technical staff, better climates.

Do engineers prefer to work in states in with allow non-competes to stand? In my 30 years in high tech, I've never heard of a single person identify state-laws regarding non-competes as a decision factor for the location of their company or job. My common sense is that this is a pretty low level issue.

I think you are on the right track however to study how state policy and legal issues as a group, encourage or discourage, industry and high tech. For instance, I think all state funded academic research should be vetted for usefulness for industry to make it significant and meaningful.

Anonymous

Regarding the enfoceability of the non-competes, wouldn't it be the juridiction of the state in which the non-compete was signed that would prevail? One would think that the violation of a non-compete contract would be a civil matter. Wouldn't the case of a non-compete contract signed in Michigan be brought before a court in Michigan regardless of where the employee emigrated?

I can see where ATTRACTING talent could have been affected by this change in the law, but it's not clear to me that the law would have the effect of driving talent away. Some of the other commentators may be correct that there were many other more plausible, coincidental, reasons for the emigration than the change in the law.

In my opinion the research took a narrow view of the subject and has serious flaws.

It should be noted that Michigan still has a vibrant talent pool involved in the development of numerous and diverse technologies.

Kapil Kumar Sopory

Company Secretary, SMEC(India) Private Limited

I'm not aware of the differing laws in various US states as far as inclusion of non-compete clause in hiring terms is concerned. However, with the type of cut-throat competition and insider spying
and surreptitious data transfer to competitors by unsrupulous staff, non-compete clause would be a useful check to a great extent.
In India, many commercial banks restrict retiring employees not to take up jobs in their competitor banks for a specified period. Obviously, after this period the concerned wold not have the past clout and would not be able hurt the interests of the present employer.

Jugal

DyCE(ERP), OIL (India)

To find a cause during research work, there may be various parameters affecting the cause. Considering only one/two visible parameter to draw final conclusion may give distorted result. Whenever there is brain drain, it flows from low potential field to high potential field. That means there must be external hidden force (opportunity) on the other side. The positive aspect also to be viewed along with negative aspect during the study in details. Good study.
Regards.

Jugal

Lokesh V

CEO, Innomantra Consulting Private Limited

In the present days - Open Innovation trend techiesvery much participates in polls, cracking the problems posted on Innovation portals by various companies, social innovation portals like xprize foundation and winners are rewarded.

In that case how once can restrict / keep a tab on each technocrat. Non-Compete is not only once the employee quits the organisation. How to restrict employees not participate in competitor's window of Innovation process while he is still with the employer.